The peso is strengthening on today's news that the Central Bank of Mexico raised its benchmark interest rate by 50 basis points, on top of a 50-point rise in November. Mexican equities were lower, however, with the iShares MSCI Mexico Capped exchange-traded fund (EWW) down fractionally while the iShares Latin America 40 ETF (ILF) was up 0.4%.

Aberdeen analyst Andrew Stanners writes:

“This is more aggressive than most people were expecting. The central bank is waging an unofficial battle to try to support the currency. They’ve been one of the most aggressive central banks in terms of hiking, even at a time when inflation has been below their official target. That’s partly because of a hangover of the Tequila Crisis when a depreciating currency presaged an economic crisis. Times have changed but a depreciating currency brings back bad memories in the minds of many Mexicans. The brutal truth is that, at the moment, Mexico’s fortunes are defined more by what president-elect Donald Trump might do in office than anything that the Central might do. We’ve become accustomed to the idea that central bankers are seen as masters of the universe. Mexico is a good example of how that balance of power is changing with politics now trumping central banks.”

" ... while the peso has stabilised in recent week, policymakers will remain focussed on containing the inflationary pass-through from a weaker currency.

17 out of 26 analysts expected a smaller 25bp hike at today's meeting, one expected no change at all and eight (including us) predicted the larger 50bp move. The accompanying statement cites two reasons behind the decision. The first is to contain so-called "second round" effects from the drop in the peso. With headline inflation likely to break above the 4% ceiling of the central bank's target range over the next six months, policymakers are increasingly focussed on anchoring expectations. The second reason is that the Fed is back in tightening mode. The accompanying statement retains the usual line that policymakers will "remain vigiliant" on the "relative monetary policy positions" between Mexico and the US, but the reality is that, for now at least, Banxico wants to keep one step ahead of the Fed.

Accordingly, there's nothing here to suggest that Mexico's central bank is thinking about slowing the pace of tightening. Our forecast is for interest rates to be increased by a further 100bp to 6.75% by end-17, which is above what is priced into the market (6.50%) and expected the consensus (just 6.00%)."

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